Coal producers in the U.S. are looking to markets abroad to make up for decreasing demand at home. But a recent investigation by Thomson Reuters news service suggests there might be royalty underpayments on those shipments. Wyoming Public Radio’s Irina Zhorov reports that royalty question is still unresolved.

IRINA ZHOROV: In 2012, the United States set an all-time record in coal exports, sending more than 124 million tons of coal overseas. That superlative reflects what has become unofficial policy for coal producers in the shrinking U.S. market – if the market is slowing, perhaps Asia will be the solution.

There’s a problem though. On coal mined from federal lands – which in Wyoming is about 80% of total coal produced - companies pay a 12.5% royalty to the federal government, which is then shared with the state. But, 12.5% of what?

MARK SQUILLACE: If the coal is being sold at $10 a ton, for example, you’d pay your 12.5% royalty on that $10 a ton. If, though, the coal is subsequently being exported then sold to China for $90 a ton, then the government is not collecting royalty on that higher value.

ZHOROV: That’s Mark Squillace, Director of the Natural Resources Law Center at University of Colorado Law

Basically, no one really thought the U.S. would be exporting raw natural resources, and current laws on coal valuation reflect that.

SQUILLACE: The rules, I think it’s fair to say, are not as clear as they might be.

ZHOROV: Some coal producers might be latching on to the ambiguity to make higher profits and return less money to the government and tax payers. Instead of selling to an independent party through an arm’s length contract and just calculating royalties using the sale price – which is pretty straightforward – they’re selling to an affiliated middleman, who resells it to someone in, for example, China, at a higher price. The parent company pockets profits from both sales but the U.S. government from just one.

The process for calculating royalties in an indirect sale – the one that’s not as clear as it might be – is supposed to come up with a number comparable to an independent sale.

In a letter, Wyoming-based Cloud Peak Energy said they calculate indirect sales by using comparable direct sales from the same mine…

But they added: “Third parties providing logistical services for coal are not subject to any extended royalty consideration, and there are no provisions in the current rules for such an extension of royalties to non-arm’s length entities.”

Most of their sales are domestic. So are they primarily looking at third-party domestic sales from the same mine to help estimate value for coal being sold abroad through middlemen? If so, they’re not taking into account the fact that the coal’s final destination values it totally differently. Like Squillace, the Colorado Law Professor, said, a ton of Wyoming coal in the U.S. is worth about $10, and in China it can be 10 times that. In other words, not exactly comparable. In 2011 Cloud Peak exported less than 5% of its coal overseas, but that accounted for almost 20% of its total revenue.

Squillace says it’s important to remember that these minerals belong to U.S. citizens.

SQUILLACE: The government is supposed to get fair market value for the coal. The problem that I’ve always had with the way the government determines fair market value, looking at local prices for coal, when the coal’s actually being sold on a global market.

ZHOROV: And Squillace adds that while the way you calculate the coal’s worth for affiliate sales might be confusing, the rules are quite clear in their intentions.

SQUILLACE: What they essentially say is look, in deciding what the value of the coal is, you have to look at what the coal has been sold at, what the gross proceeds from the sale would have been if there had been an arm’s length contract. That’s what the rules say.

ZHOROV: In its handbook, the Office of Natural Resource Revenue says the overriding principle for valuing coal is: “Under any selling arrangement, the minimum value on which royalty is based is the gross proceeds accruing to the seller or his affiliate.”

Coal exports out of Wyoming are currently small, about 1% of total production. Almost all sales are audited. Here is Director if the Wyoming Department of Audit, Jeff Vogel:

JEFF VOGEL: Our audit coverage is about 100%, it’s 99.5 %, there’s just a small portion that isn’t audited of the coal industry. And of that amount, we find, based off our audits, that the industry is compliant about 99.5% as well. So there is no issue as far as the royalty payments being made to the federal government here in Wyoming.

SHAWN REESE: I don’t think that there is any sort of nefarious activity on the part of the coal companies. They’re acting in good faith. They’re providing their returns, it’s being audited. I think the question is whether the rules have adequate mechanisms to value those non-arm’s length agreements.

ZHOROV: In other words, it’s not the companies that are bad, it’s the rules.

The Office of Natural Resource Revenue is already in the process of re-evaluating these rules. When it solicited comments in 2011 the Wyoming Department of Audit responded that the benchmarks used for valuation of indirect sales were not workable. Industry, for the most part, disagreed.

In Cloud Peak’s letter, CEO Colin Marshall says the accusations of underpayment are part of the war on coal that the current administration has consistently been accused of.

The Department of the Interior, for its part, has acted quickly. After a letter inquiring about potential underpayments from Senators Wyden, of Oregon, and Murkowski, of Alaska, the agency set up a task force and action plan to investigate whether there has indeed been any wrongdoing. Wyoming’s Department of Audit is on the task force. Here’s Director Vogel:

VOGEL: It’s a very well thought-out comprehensive plan and very constructive plan, from our point of view. It’s the nature of the auditing business to look back at what’s been done, what’s been recorded. In this case we’re going to be looking at did we follow governmental auditing standards when we looked at these coal sales?

ZHOROV: The problem, though, is that the U.S. Department of the Interior has not released its own, official reading of the regulations. The rules are still open to debate. So it’s doubtful Vogel and his auditing team will come up with anything different than before.